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Can global property keep investors smiling?
By Faith Glasgow
Commercial property funds have enjoyed great success in recent years. Despite being a relatively low-risk investment, the average UK property fund produced a return of almost 90% in the five years to August 2007, according to Morningstar.
Many people have been seduced by the apparent promise of security coupled with returns of up to 20% a year. Indeed, according to the Investment Management Association (IMA), property funds accounted for more than 23% of total net retail sales in 2006.
However, many investors have overlooked the fact that property is a cyclical sector and that the cycle is moving on. As 2007 drew to a close, news stories reported property fund woes as values tumbled, but the problems were already stacking up in the first half of 2007, when investors, particularly pension funds, started to pull money out of these funds.
As Barry MacLennan, investment director of Standard Life Investments, explains, UK commercial property price rises have been far outstripping increases in rental income - one of the big attractions of property investment. As a result, yields (a property's rental income as a proportion of the price) have been pushed down. "The primary component of property investment has traditionally been rental income," he says, "but over the last year or so investors have been seeking capital appreciation, so when prices stopped rising they started getting cold feet."
The situation has been made worse by higher interest rates and the knock-on effects of the credit crunch. On average, funds invested in UK property lost over 20% of their value over the 12 months to 7 January, according to Morningstar, while one of the worst-hit funds, Aberdeen Property Shares, lost over a third of its value, placing it among the worst-performing of all funds over this period.
Stagnant UK sector
Philippa Gee, investment director at independent financial adviser Torquil Clark, believes that, once the recent panic selling has settled down, the UK commercial property sector will stagnate for the next two or three years, while Mike Horseman at IFA Cockburn Lucas in Manchester anticipates a year or so of negative returns, before a return to the sector's long-term levels of 6% to 8% a year. So, is there now a strong argument for looking beyond the UK to global property opportunities?
It's not hard to see why a number of fund managers, faced with an overheating UK market and continuing investor enthusiasm, have turned their attention to developing funds investing in other regions, particularly in Europe and Asia. But should investors be taking advantage of them?
Perhaps the biggest single reason to invest in property is that it helps diversify your investment base away from equities, reducing the risk of making a loss if stockmarkets tumble.
With global property funds, this diversification argument becomes even stronger. Direct property (bricks and mortar) investment returns in other countries are not closely linked with what's going on in global stockmarkets, while different property markets have a low correlation with each other. So, a cyclical dip in one country will not necessarily spread to other property markets.
"Recession in the UK would have a knock-on effect on commercial property, but what happens in the economies of Singapore or China will have much less impact on UK or European property," Horseman says, "so we would never recommend putting everything into one region." Moreover, as Barry MacLennan points out, property cycles have different qualities in emerging markets. They are longer and more muted in the west, and shorter and sharper in the east, so it's sensible to have a spread.
Guy Morrell, manager of HSBC's multimanager global property fund, says: "Even listed property markets - for example, real estate investment trusts (REITs) and property companies - are more weakly correlated with each other than other sectors of the equity markets."
Greater variety
As well as reducing risk, global property offers greater choice, an increased supply of investment opportunities, more scope to move between markets and better returns, particularly given the current gloom in the UK market. Although, Morrell warns that: "Global property returns generally may well be lower in many countries than those enjoyed in recent years." But commercial property should be viewed over the long term, and in that respect the global demand outlook is strong.
However, there is a potential downside to a global approach. For a start, most of the main global property funds readily available to private investors focus mainly on property shares rather than bricks and mortar, and are therefore still susceptible to stockmarket volatility. Indeed, like UK funds, they have had a difficult time over the last 12 months on the back of negative investor sentiment.
Also, there are additional uncertainties to take into account. These range from the risk of economic or political upheaval in emerging markets to exchange rate fluctuation. Moreover, global fund managers have a huge playing field in which to operate, so they need highly specialist knowledge and the resources to research other markets effectively.
Alan Steel, managing director of Scottish IFA Alan Steel Asset Management, takes a fairly gloomy view of commercial property investment. He maintains that falling birth rates and ageing populations in the developed world mean that western economies are heading for a period of deflation that will hit commercial property hard. "We do have cautious clients who want diversification through property, but there's an inherent problem of liquidity and we're recommending that it's time to get out altogether," he explains. "If you want global exposure, global equity funds will be a better bet than property."
Most commentators are less pessimistic. Mike Horseman says: "There has to be some property in any balanced portfolio. As far as we are concerned, it will always include both UK and global elements, and both property securities and bricks and mortar."
So how can investors assess the funds on the market?
There are one or two specialist European property funds, and First State even runs a dedicated Asian fund, but Philippa Gee warns that these are high-risk investments because they are so focused. She believes a broader-based global alternative is safer.
Most global funds hold only listed property, using Reits and other types of property company. Schroders, for example, runs a Global Property Securities fund holding property companies in various countries. First State, Fidelity and JP Morgan run similarly structured funds.
But Horseman points out that these funds tend to be quite tied to the benchmark, and carry more US exposure than might make sense, given the state of the US economy. Instead, he favours boutique managers, such as the Thames River and Sarasin property funds, which he says are more flexible.
New Star has bucked the trend by launching a global fund based entirely in bricks and mortar, investing in properties in continental Europe, Asia and the Pacific Rim. "If I had to invest in property today, I would go for a global option, and New Star's fund has a strong team and an attractive new proposition that is not equity based," says Philippa Gee. Interestingly, Morningstar's figures show that New Star's offering is the only one to manage a positive return over the last three months.
Standard Life Investments has taken a hybrid approach. Approximately 80% of its portfolio is in quoted property stocks from countries such as Brazil, India, China, Taiwan and South Africa, adding liquidity to direct property holdings concentrated mainly in Europe. "Of course, if you hold bricks and mortar you miss out on the full extent of stockmarket rises - but you reduce the risk of volatility," says Barry MacLennan.
The hybrid model is also favoured by HSBC's multimanager team. "Our exposure to funds invested in listed property securities provides liquidity and exposure to markets that are otherwise difficult to access," says Guy Morrell.
So how should investors use these funds? "Global funds tend to have somewhat higher costs attached, so you need to go into them for the right reasons, and I'd say that means diversification," says Gee.
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